Eisenhart: One more crystal ball

With industry predictions for 2007 coming thick and fast as the year winds down, I would be remiss not to throw my editorial hat in the ring.

Among the safer bets for what will happen in terms of front-, middle- and back-office operations next year, I expect buy-side interest in multi-asset trading and execution management systems to continue percolating, while sell-side vendors eager to win over more investment management clients will make these systems more compatible with buy-side firms' operational requirements.

Risk management operations will break out further from middle offices and align more closely with trading operations, and managers and their service providers will undoubtedly make incremental progress in automating back-office settlement (and reducing backlogs) for more complicated instruments. No surprises here, really.

In the compliance and regulatory realm, however, keep a look out for some fireworks. After a US appeals court overturned the SEC's hedge fund registration rule last summer, the Commission has taken a piecemeal approach to regulating the industry, implementing emergency provisions to shore up aspects of the original regulation – the Investment Advisers Act of 1940 – seemingly without the same sense of purpose its former chairman William Donaldson had brought to bear on the issue.

Industry, legal and regulatory sources I have spoken to in the past few months all expect some form of hedge fund regulation more or less resembling the SEC's original rule at some point, and indications are that many fund managers currently in compliance with the now-defunct registration rule will stay in compliance.

But a tangential development – the passing of US pension reform legislation last summer enabling hedge funds to manage larger allocations from pension funds without necessarily having to assume fiduciary status dictated by the Employee Retirement Investment Security Act (ERISA), coupled with the SEC's recent legal setback – may prove enough kindling to ignite more prescriptive action by the US Congress.

Come January, Congress will be led by Democrats who have made no secret that oversight will be a key hallmark of their reign.

Hedge fund regulation hardly proved a major campaign theme in the recent election that brought them to power, but the issue will remain on the legislative radar: if hedge fund managers eventually attract greater allocations from pension funds, lawmakers will most likely require greater accountability for those allocations. One only has to look back as recently as last summer, when Democratic lawmakers (then in the minority) sought to reinstate the SEC's authority to require hedge funds to register after the Commission's rebuttal by the US appeals court.

Their efforts came to naught, but that was before the power shift. Now the industry should ponder not whether more regulation will appear, but whether what Congress potentially pushes through resembles (or indeed exceeds) what the SEC originally intended.

Strangely, incoming Democrat legislators have recently expressed less of an appetite to tackle hedge fund regulation, according to recent New York Times reports: Christopher Dodd, incoming chairman of the Senate Banking Committee which would draft any potential hedge fund legislation, has not indicated that such legislation would be a priority under his chairmanship, while Barney Frank, one of the congressmen who sponsored the House bill effectively putting the teeth back in the SEC registration rule, now favours additional hearings on the industry rather than legislation.

Nonetheless, hedge funds' increased access to pension fund assets could well prove to be a sword of Damocles – all it would take is a single fund manager making a bad gamble with pension fund money for that sword to fall on the entire US hedge fund industry. >